Saturday, November 8, 2008

Laser Eye Surgery: Too New To Value?

LCA-Vision (LCAV) and TLC Vision (TLCV) compete in an otherwise highly fragmented laser vision correction industry. Because the surgery is elective, expensive, and not generally covered by insurance companies, demand for the surgery is cyclical. As a result, this is a tough time for these companies, and the market has punished the stocks. But this is a relatively new it too new an industry for us to confidently assess the earnings power of these companies?

After all, value investors prefer to buy businesses that have proven themselves over the course of many businesses cycles. In such cases, one can more accurately predict a company's earnings power. If one can accurately predict the earnings power, one can be confident that after applying a margin of safety, one is getting a good deal.

For example, if Coca-Cola had been invented 10 years ago, perhaps value investors would be hesitant to buy stock...could it be a fad? might it have long-term health effects? But after many successful years, Coke qualifies for consideration, and value investors look for opportunities to buy it at a discount, as we saw when we looked at a graph of its historical P/E over time.

In the same way, we don't know the long-term implications for laser-corrected vision. The market for this surgery is also unknown. The surgeries have been accessible since the 1990s, but only really gained acceptance in the last decade. Here, a look at the total number of annual surgeries may be of assistance:

A few things stand out on this chart. First, we see it's a relatively new industry, with tremendous growth in the late 1990s. Second, we see how cyclical demand is (see the recession of 2002), and how its tied to economic growth. (Note that the 2008 number is an estimate from November 2007; the current 2008 estimate is likely much lower considering the state of the economy.) But we already knew these first two points.

Perhaps the most important thing we can see from this chart is the secular slowdown that appears to be occurring. Despite all the credit excesses, the run-up in housing prices, and higher confidence in this surgical procedure, at no point in the decade was the surgery more demanded than in the year 2000. Furthermore, surgeries actually dropped from 2005 onward, despite a strong economy.

This raises some questions. What is the market going forward? Did all the likely adopters already have the surgery, meaning the sustainable annual rate of surgeries going forward is much lower than the past cycle would indicate? What is the sustainable number of annual surgeries going forward?

These are tough questions to answer, but they do clarify why value investors prefer industries that are tried and tested, as there is far less uncertainty involved.

1 comment:

Doug Cress said...

Great analysis of the industry, especially the adopters piece.

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